Disappointing South African building confidence decline in 1Q11

The FNB/BER building confidence index retreated from 38 in 4Q2010 to 24 in 1Q2011. This is the same level than in 2Q2010, which was the lowest in the recession.

The index can vary between zero (indicating an extreme lack of confidence) and 100 (indicating extreme confidence). It reveals the percentage of respondents that are satisfied with prevailing business conditions in six sectors, namely architects, quantity surveyors, building contractors, building sub-contractors, manufacturers of building materials (cement, bricks and glass) and retailers of building material and hardware. In contrast to the RMB/BER BCI, which includes only building contractors, the FNB/BER building confidence index covers the whole pipeline, from planning (represented by the architects and quantity surveyors), renovation (retail trade of building materials) and production (manufacturing of building materials) to the actual construction of buildings by main and sub-contractors.

The renewed decline in the FNB/BER building confidence index is disappointing for a number of reasons.

Although some retreat was to be expected after the index jumped to a two year high in 4Q2010, the size of the decline is much bigger than could realistically have been anticipated. Not only did the index decline to the same level of around 30 that prevailed during most of 2010, but it surpassed it and dropped to the lowest level in the recession.

The fourth quarter increase in the index was spurred by the sectors at the start of the pipeline, namely planning (architects and quantity surveyors) and renovation (represented by the building material merchants). This boded well for the building industry, as an upturn in these sectors usually foreshadows a recovery in the actual construction of buildings.

Confidence in all these leading sectors faltered unexpectedly during 1Q2011. The confidence of architects dropped from 48 to 26, that of quantity surveyors from 47 to 33 and that of building material merchants from 53 to 28. “The decline in the confidence of these leading sectors of the building industry is disappointing, as it signifies that it will take longer than previously expected for actual building activity to recover”.

Whereas confidence in the other sectors covered by the BER, namely the manufacturing sector, retail trade, wholesale trade and motor trade, have all recovered from their recessionary low points and moved to net positive territory (i.e. above 50, which indicates that the majority of respondents rated prevailing business conditions as satisfactory), all the signs of recovery in the building sector that emerged during the fourth quarter disappeared in the current quarter.

Never before in the 36 year history of the BER’s business confidence index has building confidence failed to reach its lowest point at the same time as the other sectors. During 1Q2011, the confidence of building contractors declined from 20 to 18, which is the lowest level in 11 years. However, it needs to be borne in mind that the current level is nevertheless higher compared to those registered during the previous three downturns, when building contractor confidence reached low points of 9 in 1998, 11 in 1992 and 1 in 1985.

The drop in the confidence of architects and quantity surveyors can be attributed to an unexpected turn for the worse in the number of contracts awarded. Not only did the number of contracts awarded decline at a much higher rate compared to the fourth quarter, but the number of projects at sketch plan stage also fell sharply in the case of architects. This postponement of mainly non-residential projects can to a large extent be attributed to an oversupply / inventory overhang (which led to high vacancy rates and falling real rentals) and the strict criteria applied to all new bank loan applications.

The confidence of building material merchants declined on the back of slower growth in sales volumes. This slowdown is not entirely surprising, as the recovery was predominantly driven by a small market made up of households and firms that can afford to finance renovations out of their own pockets. (Such activity is not registered in the official numbers for bank credit or building plans passed.) More lively and sustainable growth in building materials requires that the market broadens. This, in turn, calls for more households and firms to invest in upgrading and renovating buildings out of their own pockets or to obtain bank loans to do so.

The fall in the confidence of manufacturers of building materials from 27 in 4Q2010 to 4 in 1Q2011 probably reflects disappointment that the demand from especially the civil engineering industry did not pick up. Demand from the residential and non-residential building industry is expected to continue to recover albeit at a later stage.

As mentioned earlier, the confidence of main contractors declined to 18 in 1Q2011 from 20 in 4Q2010 due primarily to the unrelenting contraction in building activity. Non-residential building activity continued to retreat at a higher rate than residential activity, although the tempo of decline in non-residential activity eased somewhat and that of residential activity picked up slightly during the first quarter relative to the fourth quarter. “The lack of demand for building work led to fierce tendering competition, which in turn continued to erode profitability and forced firms to keep on retrenching staff“.

The confidence of sub-contractors (i.e. specialised contractors such as plumbers, electricians, carpenters and shop fitters) increased marginally from 34 in 4Q2010 to 36 in 1Q2011. Given that they depend to a large extent on the main contractors for work, it is not surprising that they experienced the same conditions, namely an unrelenting decline in activity, fierce tendering competition and suppressed profitability. Retro fitting and renovations turned out an independent (i.e. work not stemming from main contractors) boost to non-residential sub-contractors. However, this appears to have come to an unexpected halt in the first quarter. (This, in turn, contributed to the slower growth that building material merchants experienced in the first quarter, as pointed out earlier.)

In conclusion: The disappearance of all signs of a recovery in the building sector that emerged in 4Q2010 is disappointing and has dropped us in unchartered territory.

Historically building contractor confidence recovers at the same time as the other sectors the BER surveys. Furthermore, a recovery in the leading building sectors (i.e. those involved in planning and renovation) usually foreshadows a rebound in actual building activity. At the moment none of these historical patterns hold true. So, this time around it has become impossible to foretell when the building sector is going to recover based on the historical evidence alone.

The size, tempo and duration of the previous upturn in the building industry as well as the change in the behaviour of banks following the introduction of the new credit act (NCA) and the global financial crises are probably the two main reasons why the typical cyclical recovery and the stimulatory effect of the low interest rate have so far not kicked in.

The expectations of the respondents are also not helpful in predicting the turning point. Respondents have been expecting a turnaround for many quarters and thus far none has materialised.

Therefore, the only option is to wait for signs that the building sector is recovering. When these signals appear, then the normal recovery of the building cycle will likely hold as in the past.